Easily Choosing the Best Business Structure Between the 4 Types

Choosing the best business structure is an important issue to decide on prior to starting a business. Choosing the best business structure affects everything from day-to-day operations, your taxes, risk, and rewards. Read below and chose wisely which gives you the best balance of protection and flexibility for your individual needs. I will leave links to more detailed articles I have written under each structure section.

Content:

• Sole proprietorship
• Partnership
• LLC
• Corporations
• Tax levels of LLC and Corporation

Choosing the Best Business Structure: Sole Proprietorship

A sole proprietorship is the simplest and most common structure chosen to start a business. The reason for this is that it is an unincorporated business owned and run by one individual. While you are allowed to operate under a trade name if you wish, there is no distinction between the business and the one owner.

The owner is entitled to all profits that the business is generating, but are personally responsible for all the business debts, losses, and liabilities as well. This is the most basic for of business therefore anyone doing business solo, whether registering it or not, will be by default considered a sole proprietor for business, legal, and tax reasons. This is a good choice if you are starting a low-risk business or just want to test your business viability before spending money on other structures.

Advantages to Sole Proprietorship

1. Easy and inexpensive to form.
2. Complete control
3. Easiest tax prep

Disadvantages to Sole Proprietorship

1. Complete liability.
2. Totally responsible for funding or raising funds
3. The complete burden of success/failure

Choosing the Best Business Structure: Partnership

A partnership is the simplest and most common structure for a business with two or more owners. Like the sole proprietorship, the business is unincorporated and therefore owned and run by the partners. Again, while a trade name can be chosen to operate under, there is no distinction between the business and the owners.

The owners are entitled to all the profits as a whole, each in their pro rata share of ownership of the business. While most businesses are equal splits, the ownership of the business can be divided in any way that adds up to 100% ownership by the two or more partners. While that means that each partner only gets their predetermined portion of the profits, it also means that they only bear their predetermined portion of the business’s losses too.

It also needs to be pointed out that all partners bear 100% responsibility for the business’s debts and liabilities. This being the most basic form of business with two or more, it is the default for business, legal, and tax reasons. Good choices for this formation are still low-risk businesses and for testing viability.

Advantages

1. Fairly easy and inexpensive to set up and form
2. Fairly easy tax prep
3. Each less responsible for funding and success/failure

Disadvantages

1. Less control than a sole owner
2. Each still could bear complete liability

Choosing the Best Business Structure: Limited Liability Company

This is a hybrid business entity that features elements for corporate protections and noncorporate control. LLC’s owners are called members and can be single-member or multiple-member owned. Each person owns “stock” in the company similar to publicly traded corporations but without the ability to “trade” their shares.

Unlike sole proprietorships and partnerships, an LLC is considered a separate entity or “person” than the individual owner or owners. The LLC bears the risk, debt, and liabilities of itself, not the owner(s). It forms what is called in legal jargon “a corporate veil”. This allows the owner to have personal savings, investments, ownership of real estate or personal property is not at risk to the debts or liabilities of the business.

Like with the sole proprietor and partnership structure, the owner(s) of an LLC are considered self-employed.  Depending on the tax structure discussed below, usually, the profits/losses of the business are “passed through” to the owner(s) so that there is no corporate tax if a profit. LLC’s are a good choice for businesses that are medium to high risk or after outgrowing the sole or partnership structures.

Advantages

1. Corporate protections if you follow requirements
2. Little more work, but usually not hard to set up

Disadvantages

1. More work to maintain the “corporate veil”
2. More expense and effort to correctly set up

Choosing the Best Business Structure: LP, LLP, and PLLP

After the invention of LLC, some states have come up with Limited Partners, Limited Liability Partners, and Professional Limited Liability Partners structures. Each state that allows these may have nuisances to their set up, but they are also attempting to give corporate protections to company structures. An LP is a partnership that has one general partner who has unlimited liability and all other partners are limited partners (both in liability and control).

LLP is almost exactly like LLC’s but states sometimes have some restrictions to kinds of requirements that may be a little less on LLP over LLC. A PLLP is simply an LP or LLP structure that is only available to certain professions (usually just legal, medical, and accounting), who provide professional services and may have a few more or fewer restrictions on setting up and maintaining. These are best for the medium to high-risk businesses that the state’s rules and regulations give them better protection or freedom of control than the LLC structure.

Choosing the Best Business Structure: Corporations

Corporations are legal entities that are completely separate from their owners. They are like creating a legal but fictitious person who can own real and personal property, borrow and lend money, own their own taxes and be held legally liable. They are considered to offer their owners the strongest protection from personal liability but bear the highest cost to create and maintain.

While most people think of public traded organizations, corporations can be privately held too. And while rare, can be held by just one stockholder. While you will hear and find different types of corporate type names, but these are actually tax structures that will be explained below.

A corporation usually has a board of directors who are elected by the shareholders to see after the overall mission on goals of the business and officers hired by the board to see to the day-to-day management that leads to these goals. Since the corporate structure and the owners are completely separate entities, the owners of a corporation’s stock usually are allowed to buy and sell their shares without it having an effect on the business to operate, allowing a corporation to in essence be ever-living. Often states require the ending of a sole proprietorship or partnership and opening of another to have a switch in ownership.

Advantages

1. Creates a legal entity so most protection for owners
2. Ease of raising money through stock sales or being more desirable to lenders

Disadvantages

1. Hardest to create and maintain
2. Highly regulated and periodic required reporting
3. Possible double taxation

Choosing the Best Business Structure: Cooperative

A cooperative is a business or organization owned by and operated for the benefit of those using its services. Any profits and earnings generated by the cooperative are distributed among its members, also known as user-owners. Typically, an elected board of directors and officers run the cooperative while regular members have voting power to control the direction of the cooperative. Members can become part of the cooperative by purchasing shares, although unlike LLC or Corporate stock, the amount of shares they hold does not affect the weight of their vote. Examples of this might be a utility company or a few banking structures.

Tax Effects on Choosing the Best Business Structure

Businesses when they are set up register with the IRS to receive an EIN number, which is like a person’s social security number if they are not just a sole proprietor under their social security number or a partnership under all the owners’ individual social security numbers. At the time of filing for the EIN, the business will declare its initial status that is available to them. While this status can be changed, it is usually only by one given time of year to change the next tax year and requires additional paperwork file (and approval) by the IRS.

All sole proprietors and partnerships are pass-through entities where the profits and losses are filed on the owner(s) personal tax returns. The owner is not only responsible for paying usual income taxes, but also will be responsible for paying self-employment taxes that cover things like Social Security and Medicare.

LP’s one unlimited partner pays both regular tax and self-employment tax, but the limited partners only pay regular taxes and are not responsible for paying self-employment tax, similar to owners in upcoming statuses who only receive dividends.

LLC’s can be selected as full pass-through, S-Corp status, or C-Corp status. Full pass-through status is taxed like the sole proprietorship or partnership, with regular and self-employment taxes being paid on all profits.

S-Corp status on LLC’s allow the owner(s) who are workers in the business to draw a “reasonable” salary from profits, which will be taxed both on regular and self-employment taxes; and pay part of profits as dividends, which do not get taxed on self-employment, just regular income taxes. It is also important to note that an S-Corp status is only available to LLC’s who have 100 or fewer owners, all having to be US residents.

C-Corp status for an LLC is where the LLC would pay taxes on the profits of the business on their own tax returns and the owners would pay taxes only on what they were paid in either salary, dividend, or a combination of both on their personal taxes. Dividends are not considered an expense of an LLC so that money would be double taxed- first as part of profits reported on the LLC’s tax return and then second as income for the owner’s own personal returns.

Corporations can take status is several categories, but not all are recognized by every state and those that do might have different rules. S-Corp and C-Corp status are the same as with LLC’s as they are just “borrowed” status, hence the names.

Another type is a nonprofit corporation- organized to do charity, education, religious, literary, or scientific work. Because of their viewed benefits to public welfare, these receive tax-exempt status, meaning they don’t pay state and federal taxes on the profits they make. Profits cannot be distributed.

Here is a diagram that might help to understand a little better.

All 50 Secretary of State Sites

Please click on your state of interest for their Secretary of State’s office to see available structures and fees

Choosing the best business structure is not easy, but hopefully, this article has helped you understand the advantages and disadvantages. If you need more information, I have more detailed articles on each business structure in the buttons under each section.

Good luck in choosing the best business structure for you and good luck in all your endeavors!